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Press Release

“Use It or Lose It” Is Not the Way Energy Markets Work

It has been widely reported that the United States faces an energy crisis of epic proportions. This perceived crisis has left Americans facing significant pain at the pump, as the price of gasoline continues to rise and oil prices repeatedly stretch to record highs. In response, politicians from both sides of the aisle have scrambled to offer solutions in an attempt to soothe public anger over the costly impact of higher gas prices. While Republicans have argued for drilling in the Arctic National Wildlife Refuge (ANWR) and the Outer Continental Shelf (OCS), Congressional Democrats responded with a counterclaim: oil companies need to use what they already have.

To that end, House Democrats have proposed “use it or lose it” legislation that would apply to leases on federal land. The Minerals Management Service (MMS), an agency of the U.S. Department of the Interior, manages these leases of federal onshore and offshore lands to energy companies for development purposes. After leasing a federal property, a company is entitled to develop the energy resources available on that land. There are about 47.5 million acres of federal onshore land currently leased to energy companies, with just over 13 million acres classified as “producing” by MMS. About 20 percent of OCS is currently available for leases. Energy companies have leased roughly 44 million acres of this area, including about 10.5 million producing acres. The seemingly low numbers of producing acreage has prompted claims by Democrats that oil companies are intentionally driving prices higher by refusing to produce from available oil resources. However, this claim is very misleading and deserves closer inspection.

The process of securing leases to federal lands can cost millions, even billions, of dollars for energy companies. However, leases for land in OCS are frequently secured with only minimal knowledge of the production possibilities of that land. Therefore, once the land has been leased, the company must conduct costly and time-consuming surveys to establish the prospects for the land. If the survey does not demonstrate a commercially viable resource, then companies have no economic incentive to proceed with the development of the area. The rent on a non-developable area, however, must still be paid to the federal government for the duration of the lease regardless of whether or not the land is actually useful to the companies. This exposes the fallacious nature of the “use it or lose it” legislation proposed by the Congressional Democrats.

If a company discovers oil or natural gas in commercially developable quantities, then the company will certainly develop the resource. However, the necessary studies and construction associated with development can take a significant amount of time. This process can be further delayed by regulatory requirements or lawsuits challenging the development. Sometimes, development can take seven to ten years before production finally begins. Once production starts, energy companies must pay royalties on their production to the federal government in addition to the rent on the land. In 2007, royalties and rents amounted to over $7 billion for offshore leases.

So how does the “use it or lose it” bill fit in? It would prohibit new leases from being issued to energy companies that hold “non-producing” leases. However, “non-producing” includes the land that is not commercially developable or is still being surveyed. Companies would therefore be unable to secure new leases during the years-long research and surveying process on the leases that they already hold. Additionally, even a commercially developable lease would be subjected to at least doubled rent costs after the initial five-year lease allowed under the bill.

Companies already undertake massive risks when leasing offshore lands without prior research. This legislation would intensify their gamble, as a company would not be able to diversify its risk by betting on various leases. Simply stated, exploration would be stymied. By creating such a significant limitation on energy exploration, this legislation would drastically reduce actual energy development rather than increase it. Domestic production would eventually decline as development falters, and our reliance on foreign oil will increase.

Fortunately, the “use it or lose it” bill has been temporarily stymied, as it failed to pass on June 26 by the two-thirds majority required by House rules. However, the bill still garnered 223 yeas to 195 nays. Obviously, many members of Congress are far too willing to support a poor policy that would only exacerbate the damage to an American public already reeling from high prices. With such a worrisome level of support, this issue is certain to return. It seems that many elected officials are far too anxious to castigate energy companies as a greedy big business that gouges consumers at the pump. Instead, Congress should allow leases on both federal onshore and offshore lands without costly and unnecessary “use it or lose it” clauses. Otherwise, the temporary pain that Americans are feeling at the pump will become a chronic ailment with little possible remedy.